Transparent reporting

Recommendation 4

Develop a reporting template for Australian authorised deposit-taking institution capital ratios that is transparent against the minimum Basel capital framework.

Description

APRA should develop a common reporting template that, where feasible, identifies the effect of areas where Australia’s capital framework for ADIs is different to the minimum requirements set out in the Basel framework.

Objective

Reduce disadvantages that may arise for Australian ADIs due to difficulties in comparing Australian ADI capital ratios to international peers.

Discussion

Problem the recommendation seeks to address

No benchmark of international practice exists for calculating capital ratios. All countries use variations to the minimum Basel capital framework, making it challenging to determine a common international benchmark against which to compare Australian bank capital ratios. This inhibits the relative strength of Australian banks from being accurately assessed against banks from other jurisdictions.

This problem arises because, in some areas, the Basel framework allows for more than one approach, or provides that a requirement should be specified but leaves it to national discretion to determine the detail. In addition, many individual jurisdictions adopt stronger standards than the Basel minimums. As a result, no two jurisdictions take exactly the same approach to calculating capital ratios.

Like banks in all advanced countries, Australian bank capital requirements are based on the Basel framework but adjusted to meet domestic needs. This has resulted in aspects being more stringent in some areas, and less so in others, than the approaches taken in other jurisdictions. Thus, although Australian banks can be benchmarked against the Basel minimum, they cannot be benchmarked against other countries’ practices.

Simply comparing Australian bank capital ratios to those reported by their international peers may therefore be misleading.

To make informed decisions and price debt appropriately, investors assess differences in banks’ financial strength, including capital. Although it is generally possible to identify significant differences in jurisdictions’ approaches to calculating capital ratios, estimating and comparing the effect of those differences is challenging. The banks have made substantial efforts to raise investors’ awareness of aspects of Australia’s requirements that are stronger than the minimums. However, investors are hesitant to trust banks’ self-reported adjusted capital ratios.

Quantifying the cost of this lack of comparability is difficult. Australia’s major banks have some of the highest credit ratings in the world, which may suggest that costs are limited.60 Likewise Australian bank equity valuations are among the highest in the world. However, banks contend that the lack of transparency affects market pricing. They also suggest that market access may be compromised in times of market stress, when investors are particularly risk sensitive.

The Inquiry encountered significant difficulty in comparing Australian banks’ capital ratios to those of international peers. As discussed in Recommendation 1: Capital levels, there are limited data available that try to compare capital across countries on a consistent basis, and every source that attempts this has drawbacks.

The Inquiry was presented with several estimates against different benchmarks, all of which were only able to provide a partial analysis and yielded results that varied markedly.61 This demonstrates both the value of developing a consistent approach and the difficulty of achieving it. Even where stakeholders provided estimates of how Australian bank capital ratios compared to the Basel minimum requirements — leaving aside the added difficulties of comparing directly to international banks — the results had notable differences.

The major banks submit that APRA could adequately address this issue by developing a standard template to quantify the areas where Australian bank capital ratios are more or less conservative than the minimum Basel requirements. They note that this work has begun but sought the Inquiry’s support to progress it as a priority.

APRA submits that, in implementing the Basel framework to suit the Australian environment, its primary goals is ensuring capital adequacy for each ADI. However, APRA also sees value in comparing capital ratios appropriately, particularly for the largest banks operating internationally, and has no objection to ADIs reporting a capital ratio based on Basel minimum requirements. Nevertheless, it argues that the additional requirements imposed by each jurisdiction mean it is not practically possible to compute a comparison to the practices of other jurisdictions.

Conclusion

Without action, investors may not be able to assess Australian banks’ relative capital position. This can reduce access to funding and raise funding costs, particularly at times when investors are more sensitive to risk. Given the existence of a relatively low-cost option to address this situation, it is not desirable to maintain the status quo.

This recommendation would be most beneficial if other countries implemented similar reporting mechanisms. Recognising that national discretions can impair comparisons across jurisdictions, the Basel Committee on Banking Supervision has been working to address this issue, including by publishing survey data on how different countries use discretions.62 However, even in the absence of action by other countries, introducing such reporting in Australia is still of benefit. It would translate Australian ADI capital ratios into an easily understandable, known international benchmark, even if other countries have differences within their own jurisdictions.

The Inquiry has not sought to quantify the extent to which transparent reporting may affect funding costs or access to funding. However, it notes that the benefits are likely to be more pronounced in times of market stress. Most of the cost of implementing this option would fall to the major banks, which see a substantial net benefit in this change.

The Inquiry notes that APRA has begun developing reporting in conjunction with industry in line with the current recommendation. Given this reporting would be most beneficial to banks with investors that seek exposure across banks in multiple jurisdictions, APRA should consider whether reporting should be voluntary to avoid imposing costs on those banks for which it would serve no benefit.

An alternative option is to change the way capital ratios are calculated to be more consistent with the Basel minimum framework, in effect reducing APRA’s use of national discretion. This may achieve a similar outcome with regard to international transparency. However, it would have a wider range of costs and take substantially longer to implement than the recommended option. As such, the Inquiry does not recommend this approach.

60 Many factors contribute to Australian banks’ credit ratings in addition to their capital ratios, including the strong Australian Government credit rating and the sound macro-economic environment in Australia.

61 A number of submissions addressed this issue, including from APRA, the Australian Bankers’ Association, the major banks and Mòrgij Analytics.